This paper analyzes the macroeconomic effects of fiscal and labor market po
licies in a developing economy with an informal sector and a heterogeneous
work force. A permanent reduction in government spending on nontraded goods
leads in the long run to a depreciation of the real exchange rate, a fall
in the market-clearing wage for unskilled labor, an increase in output of t
raded goods, and a lower stock of net foreign assets, A permanent reduction
in the minimum wage improves competitiveness, and expands the formal secto
r. The effect of changes in unemployment benefits are also analyzed. (C) 19
99 Elsevier Science B.V. All rights reserved. JEL classification: E24; F41;
F42.